August 28, 2009 — While the sun’s not nearly out yet, the economic sky seems to continue to brighten. Usually, that would start to foster somewhat higher interest rates — but apparently, not yet.
For their part, mortgage rates are flat. The overall average rate for 30-year fixed-rate mortgages revealed in HSH’s Fixed-Rate Mortgage Indicator (FRMI) was unchanged at 5.63% this week. The FRMI’s 5/1 Hybrid ARM counterpart rose by a single tick to 4.92%, and at 5.32%, conforming 30-year FRMs moved just two basis points higher for the week.
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We speculated a few weeks ago that the path or tempo of market-based interest rate increases might be a little different than the typical “economy’s getting better so rates must rise” scenario. As such, we might not see immediate rate increases in reaction to “good” economic news.
Aside from the enduring support of the Federal Reserve, which continues to buy up mortgage-backed securities and agency debt, our premise is that interest rates being offered for new loans reflect to a considerable degree the riskiness of loans already held by lenders, a kind of built-in firmness as delinquencies and defaults (for loans of all stripes) continue to run hot.
We think that improving economic fundamentals will mean fewer potential losses for lenders, and that in turn will begin to temper the risks of loans already on their books. The easing of risks — from improving home sales, firming home prices and flattening layoffs — may serve as a kind of counter to the building of upward pressure for rates brought about as a result of an improving economy. This is to say that we think rates might still rise, but will probably rise less overall than they otherwise would have, absent the easing of risks to held loans and securities.
Of course, that’s not to say that there is necessarily any kind of immediate effect, or that it will provide the same kind of benefit for all market participants. And there’s no guarantee that pools of bad assets won’t overwhelm the effects of a firming economy. There have been 83 bank failures already this year, and there are now some 400 more unnamed banks on the FDIC’s “watch list”. It’s clear that even improving economic fortunes will come too late to save all of them.
One of the material improvements comes in the form of rising home prices. The S&P/Case-Shiller 20-city home price index rose for a second straight month in June, its first back-to-back gain since 2006. The FHFA’s same-sales (conforming only) index noted a minor increase in prices in May, lifting by 0.5%. An improvement in the value of real-estate owned means that a foreclosed property will generate less of a loss to the lender who owns it when it sold, and can also serve to stabilize even the well-performing loans on its books.
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Another sign comes in the form of increasing home sales. Following on the heels of a spike in the sales of existing homes, sales of New Homes put in a good showing in July, notching a 9.6% increase. The 433,000 (annualized) units sold was the best such pace since last September and well above forecasts. With the quickened sales pace, inventory levels declined to just 7.5 months, the best showing in some time (about six months of stock is considered normal). The Census Bureau also noted that there were a mere 271,000 units built and ready for sale at the end of the period, so homebuilding will need to start happening fairly soon; that should also provide some economic lift. However, the end-of-November expiry of the $8,000 ‘first-time’ buyer tax credit may trim at least some marginal sales, so a muted rise in new starts is more likely than a surge.
The second look at second quarter GDP was revealed this week, but the Preliminary reading was little different than the Advance, with about the same 1% decline to show for the period. Of course, that time frame is fading into the rearview mirror, given that it ended some eight weeks ago. More recent data has come to light since then, mostly with a more positive tenor.
Working its way higher is the National Activity Index produced by the Chicago Federal Reserve. The blend of 85 economic indicators moved to -0.74 for July, its best reading since January of 2008 and a step-up from June’s -1.80 mark. The NAI seeks to measure whether the economy is growing above or below is natural trend, with zero being an “at trend” level. While we are still slightly below zero (which is probably consistent with about a 2.5% GDP), we are well above the -3.78 of last December, and steadily firming.
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Some of those indicators are of course reflective of the improving manufacturing climate. Durable goods orders rocketed ahead by 4.9% in July, goosed by aircraft and auto orders. Absent those, the ‘core’ measure of business-related spending in the report slipped back by 0.3% after a couple of months of very solid gains. At least some of those orders resulted in a good spate of activity in the Richmond Federal Reserve’s district, as their local gauge of activity came in at a reading of 14 in August, the same as July and the fourth consecutive increase. However, the uneven nature of the nascent recovery was seen over in the Kansas City district, where their yardstick went negative (-7) after spending two months on the positive side of the ledger.
The markets were soothed this week by the re-appointment of Fed Chair Ben Bernanke. While there will probably be some pointed exchanges during his confirmation hearings, there’s little doubt he will continue in his post. By most accounts, the Fed has done a very good job steering though some of the worst financial markets ever, but some very rocky shoals — removing excessive liquidity, removing easy and cheap access to “support” programs, stepping away from supporting mortgage markets — lie ahead. It’s by no means clear how well the economy will manage the expiry of these supports, or how much political interjection into the Fed’s role is yet to come.
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Sources: FRB, OTS, HSH Associates.
Whether the economy can develop any forward momentum remains an open question. Jobs creation is key to recovery, yet the unemployment rate remains uncomfortably high (and will remain so) and hiring is a thing of the future. Another 570,000 new applications for unemployment benefits were filed during the week ending August 22, about the average weekly number seen for the month so far and still elevated. Without jobs, incomes cannot grow, and the personal income report for July showed no change from June. Wages did rise by the barest amount (0.1%) during the month but remained down by 5.1% over the past year. Personal expenditures nudged 0.2% higher (-1.6% year-over-year), due to the CARS program and perhaps some back-to-school shopping. The nation’s rate of saving eased back to 4.2%, still very solid relative to the recent past.
Adjustable-rate mortgages have been getting a lot of bad press. We think it’s a bum rap. Give “In Defense of ARMs” a read and let us know what you think.
Anxiety among consumers remains palpable, if easing. The Conference Board’s measure of Consumer Confidence moved up to 54.1 in August, a fair improvement from June’s 46.6 mark but still not even as good as May’s recent “peak” 54.8 reading. The University of Michigan survey of Consumer Sentiment finished August with a final value of 65.7, just a hair below June’s level, while the weekly ABC News/Washington Post poll of Consumer Comfort ticked up by another notch to -45 for the week of August 23. It was mid-May the last time we saw a value this “high,” and we are steadily moving toward breaking the year’s high water mark of -43.
The end of the summer is usually a dull time for the markets, and this week has been no exception to the rule. We’re in a drifting pattern, if any, and that suggests that rates aren’t going anywhere too fast at the moment. Even so, it’s a busy week for data leading up to the Labor Day weekend. We’ll get the August employment report next week, but that’ll be at the end of a string of data which includes ISM indexes, auto sales, Construction Spending and the minutes of the last Fed meeting. That’s certainly a group of reports which has been known to break dull patterns before, if they contain enough collective surprises. If present trends hold true, we’ll see slightly-better-than-forecast numbers, and a Fed which has begun to ponder just how it will extricate itself from the markets. Our guess is that rates will probably firm just slightly for the week.
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